Johnny (Paulson) Got His Gun (and is aiming at some grim, Greek pickings)

Did anybody ever come back from the dead? Put the guns into our hands and we will use them. Give us the slogans and we will turn them into reality.

~ Dalton Trumbo, Johnny Got His Gun

We think Piraeus and Alpha, two banks we have a position in, are now very well capitalised and poised to recover… They have good management and we think the Greek economy is improving, which should benefit the banking sector.

~ John Paulson, of Paulson & Co.

When John Paulson moved into Greek banking shares in recent weeks, and came out in public to ‘talk up’ his new investment, Europe’s authorities and the Greek government rejoiced: Greece must, clearly, be on the mend beginning with its recently ‘recapitalised’ banks.

Paulson has made a fortune by turning himself into its hostage. Before 2008, he famously bet against the subprime market (and all the toxic derivatives that were built upon it) and emerged from the Lehman Bros wreckage fabulously wealthy.

More recently, luck turned against him. As the Euro Crisis began in earnest, he bet heavily against German bunds. And lost a great deal of money. Interestingly, at precisely the same time, other hedge funds (e.g. Hume’s Greylock and Loeb’s Third Point) made an audacious move to buy post-PSI Greek bonds, even though it was common knowledge that Greece’s debt remained (and remains) unsustainable after its two debt restructures (one being the PSI in the Spring of 2012, the other the so-called ‘debt buyback’ in December 2012).

These hedge funds effectively bet that, while Greece would stay bankrupt in perpetuity, Europe and the IMF would not allow for a further restructuring of privately held post-PSI Greek bonds again. Why? Because they were too few of these bonds left to be worth the bother. And so they bought them at 10% of face value and, indeed, made a killing when the penny dropped more widely that these bonds will be redeemed come-what-may by Europe.

Having stayed out of this bonanza, and taken his massive losses by betting against an assortment of European bonds, John Paulson decided that it was time for him to squeeze some money from the Greek corpse too. If Hume and Loeb could do it, so could he.

With the train of Greek bonds already having left the station (without him), Paulson spotted a chance of making a killing in another realm where Europe’s and the IMF’s Greek ‘intervention’ created a dichotomy between (a) the grim economic reality and (b) a vista in which external (troika) financing gave the hedge funds a golden opportunity to prosper. That realm was none else than the bankrupt Greek banks.

Greece’s second bailout entailed not only a default on bonds not already transferred onto Europe and the IMF (the so-called PSI) but also a recapitalisation of the Greek banks that were hit by this very default. The recapitalisation would be financed by the bankrupt Greek state with new loans (of €50 billion) from the EFSF-ESM. And, crucially, it would be administered by Greece’s Establishment Triangle: Governing politicians, the bankrupt bankers and the Governor of the Central Bank of Greece (who until his elevation to that post was an employee of one of these bankers).

The recapitalisation plan that was implemented is a magnificent representation of the mixture of corruption and inefficiency that typifies Europe’s response to the Euro Crisis at large. The part of this ‘mix’ that proved pertinent for John Paulson was the way in which the Greek government connived to ensure that it would not control Greek banks, even though it put up almost all the money for refloating them (piling up new huge debts, extracted from our European partners, onto the impossibly weak shoulders of the exhausted Greek taxpayers).

In essence, this was what the Greek government did (or was instructed to do by Europe, before carrying out its instructions enthusiastically): Out of €100 of new capital that was to be pumped into the banks, the government would put up €90 and the bankers would add the remaining €10. By putting in their €10, they buy not only the shares that correspond to their minor shareholding but also an option to buy at some point in the future the government’s share at the original (ultra low) share price. These options-to-buy are known in the trade as ‘warrants’. For the warrants to be activated, the share price of the bank in question would have to exceed is certain amount first – the so-called trigger prices.

In short, the government promised the bankers, and whoever else wanted to play this ‘recapitalisation game’, that, if this game led to a restoration of bank share prices to some respectable level (the trigger prices), the privateers that would get involved would receive 90% of the bank’s shares at pitiful prices. And as if that were not enough, it is now abundantly clear that even the 10% that bankers had to put down up front, was confirmed more in the breach than in the observance. As we shall see in future posts, most of it was the result of a shadow play (one banker lending non-existent monies to another) or even of hidden government handouts to the bankers.

From a public interest perspective, this game was always a lost cause. First, whatever its outcome, it will fail to restore the banks to some modicum of health so that they can start lending again. Who owns zombie banks is not the issue here. Secondly, if the ‘recapitalisation game’ fails to push bank shares to the desired level (the trigger prices), the government will have to fork out even more monies to keep them undead for longer. The bankers will simply sit tight on their very small outlay with which they retained the right to manage the nation’s financial flows. And if it succeeds so that the trigger prices are achieved, suddenly, the same bankers get ‘their’ banks back (not just the management, which they never lost, but also their shares) at a spectacularly pitiful cost while the Greek state fails to claim any part of capital gains from its investment. Heads they win, tails the Greek state loses. And all in the ‘good cause’ of keeping the bankers at the helm of the banks that went bankrupt in their watch. The Hellenic version of social welfare for bankers and tough free market conditions for everyone else.

Paulson’s strategy

Combined with Mrs Merkel’s stated decision not to let Greece drop out of the Eurozone (while at the same time denying Greece a sporting chance to recover within the Eurozone), this ‘recapitalisation game’ presented itself to Paulson (and to the assortment of other hedge funds that he pressed into his plan) as a great opportunity to make amends for two years of slim picking in Europe: Bet on the warrants!

The key to Paulson’s strategy is the separation of the banks’ shares from the warrants (which can be traded separately). Investors in the ‘recapitalisation game’ will get 90% of two major banks (the ones Paulson was talking up in the preceding quote) for next to nothing if they manage to push share prices up to a certain point (i.e. the trigger prices) so that the all-singing-all-dancing warrants can kick in (handing over to Mr Paulson and his Greek allies the coveted 90% that is now the property of the Greek government).

To this purpose, we have a consortium of hedge funds, Greek bankers and of the Greek government talking up these shares – and, of course, the banks’… new management (which, by the bye, is the same management that threw them on the rocks in the first place). Their strategy, let me repeat this once more, hinges on managing to create a bubble that will push bank share prices just above the so-called warrant trigger prices.

Alas, the ‘consortium’ of Greek Success Story groupies have not managed to come even close to the trigger prices. While the warrants, which can be traded separately from the shares, have risen in value by 100%, Alpha Banks and Piraeus Bank share (the two banks that Paulson has bet on) are up a mere 8% – i.e. nowhere near their trigger price. So, what do the good bankers do? You will not be surprised, dear reader, to hear that they have began campaigning in favour of… a lowering of the trigger price for the ‘interests of free market banking’ and in order to hasten the re-privatisation of the banks (i.e. the return to the bankers at the taxpayers cost).

“The banks and the government would like reprivatisation to be speeded up by lowering the trigger prices,” said one banker to the FT. “But the Troika is the problem.” The three-way Greek bailout agreement, overseen by the European Commission, European Central Bank and the IMF, would be likely to resist any renegotiation of the terms of the banks’ bailout, bankers concede, concludes the FT writer.

This is what we have come to: the troika is our best chance for delaying the crime of returning the banks that Europe’s taxpayers have kept undead to the bankers that oversaw their near death!

Meanwhile the Banking Crisis worsens

Most disconcertingly, the world’s financial press seems unable or unwilling to expose this wicked game. They go along with the story that Greek banks and the Greek economy are on the mend. While I understand why Paulson, his merry hedge funders and the Greek officials do this (e.g. are rejoicing that GDP will recede by ‘only’ 4% this year), I fail to see why newspapers and other media have fallen for it. Even those who have shown in the past year or so a capacity for a sophisticated analysis of what lies behind the rhetoric of the self-interested.

If they bothered to look behind Paulson’s upbeat chatter, and looked instead at the fundamentals:

they would have seen a tsunami of non-performing loans eating into any chance that the Greek banks can recover

they would have worked out Paulson’s real strategy: that he is not even that interested in waiting to see if the trigger prices are reached. For if there is an expectation in the market that they might be reached, the warrants that he received through his purchase of shares will rise further in value – at which point he can dump both his warrants and shares, cash in and leave Greece (and the risks it entails) behind him

they would have seen that the capital injections were pitiful, as in Spain, compared to the black holes in the banks’ asset books

they would have spotted that all that is happening is smart hedge funds taking advantage of the criminally designed warrants who were, most probably, put together by officials that once worked for similar hedge funds (yes, the revolving doors once again)

they would have noticed that Mr Paulson is not a strategic investor and has no interest in using his shareholding to gain seats on the board of directors so as to have a say in the clean up of the banks

they might even have got a whiff of the putrid smell of the scandals involved in keeping the present management in its place (more on that in future posts).

Epilogue

Another cruel game is being played on the back of Greece’s felled social economy. Its purpose? That the same politicians stay in government (but not in power), the same bankers retain control of what little finance there is left in the land, and that the Crisis sails on under a cloud of toxic rhetoric about a Greek success story and of an end to the Euro Crisis.

If this were just a Greek state of affairs, it would not matter much. But it is not. As always, Greece offers us excellent insights into what is going on in Spain, in Portugal, in Ireland, in Italy – even in the Netherlands and Germany itself.

Put it bluntly, a disintegrating monetary union is causing irreparable damage to our societies’ productive capacity and their social fabric while, at the same time, our officials’ response to this disintegration fails to arrest it and gives smart operators like John Paulson a variety of opportunities to profit handsomely.